Sunday, September 20, 2015

Asian finance uncertain future

While Asians think long term, their institutional framework remains short term.

Global factory: A cargo ship waits to be loaded with shipping containers at a port in Qingdao, Shandong province. China’s emergence consolidated Asia’s key role as the global factory, supplying the rest of the world with all manner of consumer goods. – Reuters

ANYONE who thinks he can predict the future of Asian finance has to know first how the Asian real economy will be doing. Projections of the future, based on past data, are notoriously inaccurate. But there are general scenarios that we can paint about the mega trends in the global economy that will certainly shape what will happen to Asia.

Roughly every five years, the US National Intelligence Council (www.dni.gov/NIC_2030_project.html) has been publishing scenarios about the future, the latest being for 2030. There are no straight line projections into the future, but rather factors that we do have some knowledge about that will impact on future outcomes.

The key trends are well known, such as demographics, urbanisation, technology and social media, globalisation, climate change and growing risks through social conflict, including terrorism, civil disruption and regional wars. The main trend that makes life much more complicated is the fact that we have moved from a uni-polar world where the US dominant position has weakened relative to the other major players.

Not only are there new powers emerging, such as the BRICS countries, but also non-state players like Isis that can fight across borders without a national identity. This makes coordinated and consistent action much more difficult to manage, which is why there is little agreement at the level of the United Nations, International Monetary Fund and other multilateral institutions.

The McKinsey Global Institute has tried to help corporate captains and policy-makers frame the uncertain future for the period 2015-2025 into basically four possible outcomes. The best scenario is a globally coordinated and distributed growth underpinned by broadening productivity increases.

Next are pockets of global growth with imbalances. Scenario three is low but stable global growth, with lots of muddling through. And the worst is continuing rolling regional crises with volatile and weak growth all round.

Stimulus packages

Most of what is likely to happen would depend on what is happening near term to stimulus packages like quantitative easing (QE) and the outlook for energy prices. Over the long term, the aging of advanced economies, rapid urbanisation (or labour migration) and technology and global connectivity will shape the final outcome.

The near-term outlook is much bleaker in the post-crisis adjustment period. Having shot the world full of steroids in terms of QE, the world’s central banks are moving in divergent paths. The Fed wants to withdraw, while the European Central Bank and Japan are still bent on using very loose monetary policy. But post-crisis, advanced country growth are roughly 2% below potential, and their demand for Asian imports are likely to remain weak.

Which is why Asian finance would depend on what happens in the next decade to the Asian global supply chain. Historians remember that the Japanese led the post-war revival of the Asian economies by being the first to supply the demand for consumer goods by the West.

After growth in Japan peaked in the 1980s, Japan invested heavily in the rest of East Asia to exploit cheap labour and increase its productive capacity. China’s emergence consolidated Asia’s key role as the global factory, supplying the rest of the world with all manner of consumer goods.

The success of the Asian global supply chain meant that Asia ran a current account surplus with the rest of the world, but mostly with the US. With rising incomes and savings, Asia became a net lender to the world, further stimulating global growth as domestic investments, an emerging middle class and demand took most of Asia to middle-income levels.

But such excessive savings were never properly intermediated within Asia. Instead, the excess savings were parked in New York and London, returning to Asia in the form of foreign direct or portfolio investments. Fundamentally, Asia did not upgrade its bank-dominated system of using short-term deposits to fund long-term investments.

Despite aging population, the level of long-term pension and insurance funds and therefore the institutionalisation of long-term savings remained small compared with the banking system.<

Low rate policies

Much of this has to do with a penchant for low interest rate policies, beginning with the Japanese attempts to reflate its economy with ultra-loose monetary policy. Excessively low interest rates meant that investments may not go to the best use of funds, while speculation in asset bubbles became more profitable than upgrading total factor productivity.

China’s stock market gyrations this year symbolise the contradictions within Asia’s financial system. On the one hand, the stock market should be the source of long-term equity much needed for giving the whole economy an equity cushion against overleveraged fragilities.

On the other, the stock market became a casino for retail punters with margin funding.

Which is why the Fed’s decision on raising interest rates has so much impact on the future of Asian finance, because New York and London remain an important intermediary for Asian excess savings.

Capital outflows back to New York and London occur precisely because as Asian excess savings unwind, interest rates will adjust upwards and Asian asset bubbles will accordingly also unwind.

The irony of Asian growth is that while Asians think long term, their institutional framework remains distinctly short term. Asian pension and insurance funds remain too small and lack the firepower and innovative imagination to be the market stabilisers that are needed for the long haul.

The Japanese pension system is the classic example of Asian institutional weakness. By putting the bulk of its savings in domestic government bonds, the system is trapped in terms of returns, since the large Japanese fiscal deficit and debt overhang (roughly twice GDP) can only be sustained by low interest rates. We then have the world’s largest net saver becoming the largest borrower, owing everything to oneself

Can the right hand of an aging person rescue its left hand? Over any demographic cycle, it is the young that will support the old, so one must invest in the young for the future to be bright.

The future of Asian finance is less a technical issue and more a mindset problem. Unless Asian policymakers start thinking more about long-term funding for its young (in thinking as well as action), it will continue to be subject to the whims of monetary policy decision in Washington DC.